Future of Leap, MetroPCS get cloudy

Analysis: Discount carriers could find strength in unity

WASHINGTON (MarketWatch) -- Just a few months ago Leap Wireless International Inc. and MetroPCS Communications Inc. were the best-performing stocks in the phone industry.

Now they're the worst.

Stocks of both companies plunged last week after they reported wider quarterly losses and added far fewer customers than Wall Street expected.

What's more, the forecast for the rest of 2009 doesn't look much better, raising questions anew on whether the two companies should reopen merger talks that failed two years ago

On Friday, shares of San Diego-based Leap
LEAP
dropped 24%. The day before, Dallas-based MetroPCS
PCS
lost a whopping 29% of its value.

After hitting a recent peak of $42.47 in late May, Leap's stock has fallen to nearly $17 and is down 36% in 2009. MetroPCS, which jumped to almost $19 in early April, has retreated to less than $9 a share and is down 41% for the year.

The reversal stems mostly from rising competition in the prepaid wireless market, which saw surging growth in late 2008 and early 2009 after the U.S. recession worsened and many consumers tried to cut their phone bills.

The deepening recession fueled large subscriber gains at Leap and MetroPCS and sent their stocks soaring. Yet it also spurred other carriers to introduce cheaper plans in an effort to grab their own piece of the growing prepaid pie.

Then in early July, the wireless reseller TracFone begin a $45 monthly plan that included unlimited phone calling and text messaging. TracFone's service runs on the nationwide network of Verizon Wireless and is sold by Wal-Mart.

Stiffer competition clearly hurt Leap and MetroPCS in the second quarter. Leap added 203,000 net customers, but analysts were expecting an average of 310,000. MetroPCS gained 206,000 net subscribers, well below Wall Street's forecast of 400,000.

By contrast, Sprint's Boost signed up a net 938,000 customers in the second quarter.

Scylla and Charybdis

The challenge now for Leap and MetroPCS is to manage costs even better than they already do. That's no easy task, with monthly revenue per user on the decline and costs expected to rise.

In the second quarter, for example, the average monthly bill paid by Leap customers dropped to $40.73 from $43.97 a year earlier. For MetroPCS, monthly revenue fell $1.53 to $40.52.

And monthly revenue per user could fall to less than $40 in the months ahead.

At the same time, Leap and MetroPCS may soon have to upgrade to the next generation of wireless technology, which is supposed to deliver faster Internet access and fewer service interruptions. Industry juggernauts AT&T Inc.
T, -0.07%
and Verizon Wireless plan to move to so-called Fourth Generation technology starting in 2010.

"AT&T and Verizon are spending a fortune on their networks," noted Jane Zweig, a wireless consultant at The Shosteck Group.

While Leap and MetroPCs have experienced record subscriber growth over the past year, it won't do the companies much good unless the newcomers eventually add to the bottom line.

Revisiting a merger

As the prospects for Leap and MetroPCS darken, some analysts and investors are raising anew the possibility of a merger. Two years ago, Leap rejected a buyout proposal from MetroPCS, saying it was too low.

Asked whether a merger makes even more sense now, Leap Chief Executive Doug Hutcheson told analysts last Thursday that he's always been open to a deal "on the right terms and conditions."

Although a Leap-MetroPCS combination would still be dwarfed by AT&T, Verizon, Sprint and T-Mobile USA, the company would clearly be in a better position to compete. It would have more than 11 million customers, wider geographical coverage, a much larger network and more financial stability.

"While the $69-per-share buyout offer from MetroPCS from the summer of 2007 is now a distant memory, we believe a deal would make sense now more than ever if for no other reason than expense control," analyst Chandan Sarka of Auriga USA wrote in a report.

"A combined company would only have to build one upgraded network as the market transitions" to fourth-generation networks.

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